Oil Prices: Recession Headwinds
View change: We are revising down our end-2022 WTI oil price forecast to $110 from $130 and to $90 for end-2023 from $110. This reflects our downward revisions to growth in a number of major countries, combined with demand destruction from high gasoline prices; a better crude oil inventory situation; and prospects that the EU insurance ban on Russian oil will likely be watered down. Lack of major new supply into 2023 will provide a floor for oil prices, however.
Figure 1: WTI Net Non-commercial Future Positions
Source: CFTC
Various Factors Take the Steam Out of Oil
A number of factors are leading to our downward revision of the WTI oil price outlook.
- Recession prospects in U.S. and Europe: Our economic view has become more negative for key economies, as negative real wages and cumulative tightening combine to produce a worsening economic backdrop. We are now forecasting a technical recession in the U.S. and parts of Europe (here) and a weak 2023 global growth picture. This has already prompted a reduction in speculative net long positions (Figure 1). Additionally, global recession fears tend to cause a quick inventory build that changes the dynamics behind price setting in the oil market and creates a willingness for producers to sell oil more cheaply.
- Demand destruction: High gasoline prices in the U.S. mean that the start of the traditional holiday driving season has been the worst since 1996. In Europe, the percentage increase in gasoline prices has been less, but the energy cost of living crisis is causing households to be more cautious. This influence could become less, however, with the noticeable fall in crude oil prices in the past two months.
- Better inventories: The combination of slower economic growth and demand destruction in certain upstream products means that the inventory picture is now less severe and getting closer to average (Figure 2). This reduces the price premium in the crude oil market.
- EU insurance ban being diluted: The oil market was more concerned about the proposed EU ban on insurance for Russian oil shipments, as it could effectively stop Asian buyers. The EU ban on seaborne oil was seen as secondary, as this oil could be diverted to Asia with the Middle East selling more oil to Europe instead. Current G7 discussions are for the EU insurance ban to be diluted or stopped due to U.S. pressure, as the U.S. fears that the ban will push oil and gasoline prices higher and the Biden administration is keen to avoid this in light of the political sensitivity before the November midterm elections.
Figure 2: OECD Oil Inventories in Number of Days
Source: U.S. EIA
Nevertheless, we do see oil prices rising in H2 2022. Firstly, we look for a technical rather than deeper recession in the U.S. Secondly, the swing in financial market positioning has already been enough, except in the scenario of a deep U.S. recession. Thirdly, supply will worsen in H2, both as OPEC+ has little effective capacity to add and as strategic oil reserve releases come to an end. Finally, we do not see a credible peace deal for the Ukraine war (here), both as the sides are too far apart and as President Vladimir Putin is playing the long game and waiting for a less aggressive U.S. administration after the 2024 U.S. presidential elections. Thus we now forecast $110 by end-2022 vs. our previous forecast of $130. End-2023 is now forecast at $90 vs. $110 previously, as weak global growth drags oil prices back down.